Vives X. Information and Learning in Markets: The Impact of Market Microstructure

Princeton University Press, 2008. – 420 p. – ISBN: 0691127433, 9780691127439The book analyzes how markets aggregate information and what impact specific market arrangements—the market microstructure—have on the aggregation process and the overall performance of the market. The book builds a bridge between the two main views of markets: informational efficiency and herding. Do prices in the stock market reflect all available information in the hands of traders and fundamental values, or are prices in the hands of shortterm speculators, insiders, manipulators, gurus and subject to fads, herding behavior, and bubbles? This is accomplished by bringing together results from the rational expectations literature and recent analysis of herding phenomena in a coherent game-theoretic framework. The strategy of the book is to analyze the different topics considering a basic workhorse asymmetric-information model in a linear-quadratic mean–variance environment. It is found that apparently contending theories, such as market informational efficiency and herding, build in fact on the same principles of Bayesian decision making. The upshot is that we do not need irrational agents to explain herding behavior, crises, and crashes. Traders may be rational but learn slowly or even on some occasions disregard private information and end up making persistent errors when acting; or they may be trapped in a coordination failure where everyone loses. However, informational and economic efficiency need not coincide and in general they will not. In any case, the impact of the details of market microstructure on the informational efficiency of the market is crucial.